A Mall divided by different city minimum wage laws @SueMoroney @GreenCatherine

The Westfield Valley Fair Mall is half in San Jose city and half in Santa Clara city. In 2012, San Jose raised its minimum wage from $8 to $10 per hour.

National Public Radio in 2014 had a brilliant broadcast on the implications of this new city minimum wage law on the Westfield Valley Fair Mall. As the broadcast said:

This change created two economic worlds within a single, large building. Employees doing more or less the same work, just steps away from each other, started making different wages.

The radio show discussed what happened on the $8 side of the Mall and then on the $10 side through interviews with employers and workers.

On the then $8 per hour minimum wage side of the Mall, employers quickly noticed that many of their employees quit to jobs elsewhere in the same Mall. These same employees found that the quality of job applicants also fell away seriously. There were noticeable differences in the personalities traits and dress standards presented by the $8 an hour job applicants and $10 an hour job applicants.

As is to be expected because information about job opportunities is costly, some of the minimum wage employees did not know that other parts of the Mall paid more.

(This change in job turnover rates and applicant pool quality subsequent to the minimum wage increase in San Jose has implications for the inequality of bargaining power between workers and employers. Minimum wage workers do keep an eye on competing opportunities and take them up when better options arise – JR aside).

Since 2012, the minimum wage rates in the Mall have changed again: Santa Clara’s minimum wage initially increased to $9 an hour – the state-wide minimum wage, which had increased from $8 per hour; San Jose’s $10.15 per hour.

Those city minimum wages were increased further this year to $11 in Santa Clara city and $10.30 in San Jose city respectively by the respective city councils.

The state-wide minimum wage in California is to increase to $15 per hour by 2020 under a law just passed. California’s current $10-per-hour minimum wage is already among the highest in the country — only Washington, DC, has a higher minimum wage at $10.50 per hour.

Getting back to what was said in the National Public Radio broadcast, the show then moved on to the Gap Store, which straddled the two city boundaries.

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Source: Episode 562: A Mall Divided : Planet Money : NPR.

The Gap Store had the option of keeping a record of how much time employees spent in each city within its store and pay accordingly under each city law. The Gap raised everybody’s wage to $10.

There was then a fascinating interview with a Pretzels store owner. The question she asked herself every time she bought anything was how many pretzels se had to sell to cover the cost. She quickly concluded that she could not sell enough additional pretzels to cover the wage rise.

There is another Pretzels store just around the corner from her in the same mall but in the other city so she could not raise her prices by that much. She had a picture of that day’s menu and price list of the competing Pretzels store on her smart phone.

She instead took a cut in her profit. This flowed back to her employers because they received an annual bonus based on 15% of each year’s profit. They did not like that reduction in their bonus.

In a delicious irony, this same entrepreneur owned another Pretzels store in a different part of the Mall but which was in the other city subject to the lower minimum wage law. She owned two of the three pretzels stores in that Mall.

She solved the problem in staff morale by rotating her staff in alternate weeks between her two stores in the same Mall but different cities and paying them accordingly.

In my opinion, this NPR story is pretty much a vindication of standard microeconomics of minimum wage laws. Minimum wage workers are alert to their opportunities and take the best ones available to them but this is not perfect because of cost of information. As Manning observed in his superb book Monopsony in Motion:

That important frictions exist in the labor market seems undeniable: people go to the pub to celebrate when they get a job rather than greeting the news with the shrug of the shoulders that we might expect if labor markets were frictionless.

And people go to the pub to drown their sorrows when they lose their job rather than picking up another one straight away. The importance of frictions has been recognized since at least the work of Stigler (1961, 1962).

As George Stigler argued, information is costly to obtain in the labour market and this leads to price and wage dispersion with this variance related to the cost of searching for information. He concluded that the one-price (one-wage) market will occur only where the cost of information about the prices (wages) offered by buyers and sellers is zero.

Finally, minimum wages rises threaten the profitability of businesses and therefore their survival. That puts low-pay jobs at risk. As Bhaskar, Manning and To (2002) explain in their survey paper on monopsony:

Notice also that because a binding minimum wage reduces employers’ profits when there is free entry into and exit out of the labor market, some employers will be forced to exit. Employer exit has a negative effect on total employment through the loss of exiting employer payrolls.

That is, although establishments that remain after the imposition of a minimum wage increase their employment, some employers are forced out of business.

Thus, minimum wages have two opposing effects: the employment-increasing “oligopsony” effect and the employment-reducing “exit” effect. The overall effect of a minimum wage depends on which effect dominates.

An increase in the family tax credit puts no jobs at risk and is a superior alternative to minimum wage laws. Minimum wage increases throw some low page workers onto the social scrapheap.

Some look upon these large minimum state and city wage increases as worthwhile policy experiments. As Dube said:

… 30 to 40 percent of the California workforce will get a raise … This will be a big experiment. It’s far outside of our evidence base… If you’re risk-averse, this would not be the scale at which to try things.

On the other hand, if you think that wages are really low and they’ve been low for a really long time and we can afford to take some risks, doing things at this scale will get us more evidence.

“Big experiments” to use Dube’s words such as these with state and city minimum wages laws are wrong as Robert Lucas explained in 1988:

I want to understand the connection between in the money supply and economic depressions.

One way to demonstrate that I understand this connection–I think the only really convincing way–would be for me to engineer a depression in the United States by manipulating the U.S. money supply.

I think I know how to do this, though I’m not absolutely sure, but a real virtue of the democratic system is that we do not look kindly on people who want to use our lives as a laboratory. So I will try to make my depression somewhere else.

A response to Judith Sloan on monopsony

In the monopsony view view, search frictions in the labour market generate upward sloping labour supply curves to individual firms even when firms are small relative to the labour market.

Peter Kuhn in a great review of monopsony in motion pointed out the correct title was search fictions with wage posting and random matching in motion.This precision is important because, as Kuhn goes on to say:

“Manning clearly recognizes this weakness of search-based monopsony models, and does his best to address it in his discussion of ‘random’ vs. ‘balanced’ matching on pages 284–96. Manning’s basic general-equilibrium monopsony model, set out in chapter 2, assumes ‘random matching’, which means that, regardless of its size, every firm—from the local bakery to Microsoft—receives the same absolute number of job applications per period. The only way for a firm to expand its scale of operations in this model is to offer a higher wage… it is absolutely critical to the search-based monopsony model at the core of this book that there be diminishing returns to scale in the technology for recruiting new workers. In other words, for the theory to apply, firms must find it harder to recruit a single new worker the larger the absolute number of workers they currently employ.”

The evidence in favour of the monopoly view of minimum wage is is not as good as people think.

Under this monopsony view of minimum wages – an upward sloping supply curve of labour – an increase in the minimum wage increases both wages and employment.

That is, there is a very specific joint hypothesis of both more employment and more wages and as there are more workers in the workplace, higher output which the employer can only sell by cutting their prices.

David Henderson made very good points along this line when he reviewed David Card’s book back in 1994:

Interestingly, Card’s and Krueger’s own data on price contradict one of the implications of monopsony. If monopsony is present, a minimum wage can increase employment. These added employees produce more output. For a given demand, therefore, a minimum wage should reduce the price of the output. But Card and Krueger find the opposite. They write: ‘[P]retax prices rose 4 percent faster as a result of the minimum-wage increase in New Jersey…’ (p. 54). If their data on price are to be believed, they have presented evidenceagainst the existence of monopsony. David R. Henderson, “Rush to Judgment,”MANAGERIAL AND DECISION ECONOMICS, VOL. 17, 339-344 (1996)

Is unemployment voluntary or involuntary?

Robert Lucas in a famous 1978 paper argued that all unemployment was voluntary because involuntary unemployment was a meaningless concept. He said as follows:

The worker who loses a good job in prosperous time does not volunteer to be in this situation: he has suffered a capital loss. Similarly, the firm which loses an experienced employee in depressed times suffers an undesirable capital loss.

Nevertheless the unemployed worker at any time can always find some job at once, and a firm can always fill a vacancy instantaneously. That neither typically does so by choice is not difficult to understand given the quality of the jobs and the employees which are easiest to find.

Thus there is an involuntary element in all unemployment, in the sense that no one chooses bad luck over good; there is also a voluntary element in all unemployment, in the sense that however miserable one’s current work options, one can always choose to accept them.

I agree that we all make choices subject to constraints. To say that a choice is involuntary because it is constrained by a scarcity of job-opportunities information is to say that choices are involuntary because there is scarcity.

Alchian said there are always plenty of jobs because to suppose the contrary suggests that scarcity has been abolished. Lucas elaborated further in 1987 in Models of Business Cycles:

A theory that does deal successfully with unemployment needs to address two quite distinct problems.

One is the fact that job separations tend to take the form of unilateral decisions – a worker quits, or is laid off or fired – in which negotiations over wage rates play no explicit role.

The second is that workers who lose jobs, for whatever reason, typically pass through a period of unemployment instead of taking temporary work on the ‘spot’ labour market jobs that are readily available in any economy.

Of these, the second seems to me much the more important: it does not ‘explain’ why someone is unemployed to explain why he does not have a job with company X. After all, most employed people do not have jobs with company X either.

To explain why people allocate time to a particular activity – like unemployment – we need to know why they prefer it to all other available activities: to say that I am allergic to strawberries does not ‘explain’ why I drink coffee. Neither of these puzzles is easy to understand within a Walrasian framework, and it would be good to understand both of them better, but I suggest we begin by focusing on the second of the two.

Another way to understand unemployment is to use a device at the start of Alan Manning’s book on labour market monopsony:

What happens if an employer cuts the wage it pays its workers by one cent? Much of labour economics is built on the assumption that all existing workers immediately leave the firm as that is the implication of the assumption of perfect competition in the labour market.

In such a situation an employer faces a market wage for each type of labour determined by forces beyond its control at which any number of these workers can be hired but any attempt to pay a lower wage will result in the complete inability to hire any of them at all

Suppose workers offered to work for 1 cent. Would employers accept? Many do because they have intern and work experience programmes for students, but is this result of general application?

Understanding the reallocation of labour at the end of the recession requires careful attention to the 1980s writing of Alchian on the theory of the firm. Alchian and Woodward’s 1987 ‘Reflections on a theory of the firm’ says:

… the notion of a quickly equilibrating market price is baffling save in a very few markets. Imagine an employer and an employee. Will they renegotiate price every hour, or with every perceived change in circumstances?

If the employee is a waiter in a restaurant, would the waiter’s wage be renegotiated with every new customer? Would it be renegotiated to zero when no customers are present, and then back to a high level that would extract the entire customer value when a queue appears?

… But what is the right interval for renegotiation or change in price? The usual answer ‘as soon as demand or supply changes’ is uninformative.

Alchian and Woodward then go on to a long discussion of the role of protecting composite quasi-rents from dependent resources as the decider of the timing of wage and price revisions.

Alchian and Woodward explain unemployment as a side-effect of the purpose of wage and price rigidity, which is the prevention of hold-ups over dependent assets. They note that unemployment cannot be understood until an adequate theory of the firm explains the type of contracts the members of a firm make with one another.

My interpretation is the majority of employment relationships are capital intensive long-term contracts. Employers spend a lot of time searching and screening applicants to find those that will stay longer. In less skilled jobs, and in spot market jobs, employers will hire the best applicant quickly because job turnover costs are low. Back to Manning again:

That important frictions exist in the labour market seems undeniable: people go to the pub to celebrate when they get a job rather than greeting the news with the shrug of the shoulders that we might expect if labour markets were frictionless. And people go to the pub to drown their sorrows when they lose their job rather than picking up another one straight away. The importance of frictions has been recognized since at least the work of Stigler (1961, 1962).

Whatever may be among these frictions, wage rigidity is not one of them. Wages are flexible for job stayers and certainly new starters.

See What can wages and employment tell us about the UK’s productivity puzzle? by Richard Blundell, Claire Crawford and Wenchao Jin showing that in the recent UK recession 12% of employees in the same job as 12 months ago experienced wage freezes and 21% of workers in the same job as 12 months ago experienced wage cuts. Their data covered 80% of workers in the New Earnings Survey Panel Dataset.

Larger firms lay off workers; smaller firms tended to reduce wages. This British data showing widespread wage cuts dates back to the 1980s. Recent Irish data also shows extensive wage cuts among job stayers.

See too Chris Pissarides (2009), The Unemployment Volatility Puzzle: Is Wage Stickiness the Answer? arguing the wage stickiness is not the answer since wages in new job matches are highly flexible:

  1. wages of job changers are always substantially more procyclical than the wages of job stayers.
  2. the wages of job stayers, and even of those who remain in the same job with the same employer are still mildly procyclical.
  3. there is more procyclicality in the wages of stayers in Europe than in the United States.
  4. The procyclicality of job stayers’ wages is sometimes due to bonuses, and overtime pay but it still reflects a rise in the hourly cost of labour to the firm in cyclical peaks

How do existing firms who will not cut wages survive in competition with new firms who can start workers on lower wages? Industries with many short term jobs and seasonal jobs would suffer less from wage inflexibility.

Robert Barro (1977) pointed out that wage rigidity matters little because workers can, for example, agree in advance that they will work harder when there is more work to do—that is, when the demand for a firm’s product is high—and work less hard when there is little work. Stickiness of nominal wage rates does not necessarily cause errors in the determination of labour and production.

The ability to make long-term wage contracts and include clauses that guard against opportunistic wage cuts should make the parties better off. Workers will not sign these contracts if they are against their interests. Employers do not offer these contracts, and offer more flexible wage packages, will undercut employers who are more rigid. Furthermore many workers are on performance pay that link there must wages to the profitability of the company.

How can downward wage rigidity be a scientific hypothesis if extensive international evidence of widespread wage cuts since the 1980s and 30%+ of the workforce on performance bonuses is not enough to refute it?

Alchian and Kessel in “The Meaning and Validity of the Inflation-Induced Lag of Wages Behind Prices,” Amer. Econ. Rev. 50 [March 1960]:43-66) tested the hypothesis that workers suffered from money illusion by comparing the rates of return to firms in capital intensive industries with those of labour intensive industries. Labour intensive industries were not more profitable than capital intensive industries. Employers in labour intensive industries should profit from the misperceptions of workers about wages and future prices, but they did not.  Alchian and Kessel found little evidence of a lag between wage and price changes.

In Canadian industries in the 1960s and 1970s, wage indexation ranged from zero to nearly 100%. Industries with little indexation should show substantial responses of real wage rates, employment and output to nominal shocks. Industries with lots of indexation would be affected little by nominal disturbances. Monetary shocks had positive effects but an industry’s response to these shocks bore no relation to the amount of indexation in the industry. Shaghil Ahmed (1987) found that those industries with lots of indexation were as likely as those with little indexation to respond to shocks.

If the signing of new wage contracts was important to wage rigidity, there should be unusual behaviour of employment and real wage rates just after these signings, but the results are mixed. Olivei and Tenreyro (2010) used the tendency of contracts to be signed at the start of years to show that monetary policy had significant effects in January but little effect in December because the effects were quickly undone.

Alchian (1969) lists three ways to adjust to unanticipated demand fluctuations:
• output adjustments;
• wage and price adjustments; and
• Inventories and queues (including reservations).

Alchian (1969) suggests that there is no reason for wage and price changes to be used regardless of the relative cost of these other options:
• The cost of output adjustment stems from the fact that marginal costs rise with output;
• The cost of price adjustment arises because uncertain prices and wages induce costly search by buyers and sellers seeking the best offer; and
• The third method of adjustment has holding and queuing costs.

There is a tendency for unpredicted price and wage changes to induce costly additional search. Long-term contracts including implicit contracts arise to share risks and curb opportunism over relationship-specific capital. These factors lead to queues, unemployment, spare capacity, layoffs, shortages, inventories and non-price rationing in conjunction with wage stability.

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